What happened last month?
The month of August started on a positive note for bond markets. While RBI hiked policy rates, its neutral stance on growth and inflation improved market sentiment. Consequently, we saw a small rally in the 10-year G-sec at the start of the month. However, depreciating currency and a rebound in oil prices played a spoilsport. In the following days, the 10-year G-sec lost all its gains to trade close to 8% near month-end.
Overall, the month had a fair share of positive and negative news. While currency and oil were downers, modest inflation numbers, benign banking liquidity and positive foreign investor inflows have been encouraging for the industry.
How did funds react?
The rising yields meant that funds in the shorter duration bucket such as liquid, ultra-short term funds were in a better place compared to long duration and gilt funds.
We talked with Devang Shah, Deputy Head - Fixed Income, Axis MF, Dhawal Dalal, CIO – Fixed Income, Edelweiss MF and Mahendra Kumar Jajoo - Head - Fixed Income, Mirae Asset MF to understand market triggers in September and their near term market outlook.
Key triggers for the upcoming month
The fund managers believe that market participants will be closely tracking five triggers during September. While oil, retail inflation and currency have been on everyone’s radar for the last few months, advance tax outflows, liquidity, Fed policy and half-yearly government borrowing are the month specific triggers for the market.
- Advance tax outflows: Corporates redeeming investments for tax payments will affect near term liquidity.
- Liquidity: The second half of the year traditionally sees tighter liquidity owing to festivals and advance tax outflows. “Currently, liquidity in the system is relatively tight. Moreover, once the festival season starts, we see increase in currency in the economy and outflows from the banking system. This will further tighten the liquidity. However, RBI’s neutral stance on liquidity indicates that RBI may conduct open market operations (purchase debt securities) to infuse liquidity in the system”, says Devang.
- Government borrowing program: Generally, we see higher government borrowing during the first half of the year compared to the second half, observes Dhawal. However, this was not the case during first half of FY18-19. In the current markets where demand is low, higher supply may drive up bond yields, he feels.
- Fed committee meeting: Market participants believe that Fed is likely to hike rates twice this year. A Fed rate hike may lead to stronger US$ and foreign investor outflows from the markets, believes Mahendra.
- Oil prices, currency and inflation were key parameters highlighted by RBI in the policy meeting. Thus, RBI will closely track their movement while deciding repo rate.
Outlook
Dhawal believes that US Fed is likely to hike rate twice this year. This would push US benchmark rates to 3.30%. Thus, 10 year G-sec would need to rise to 8.25% to be attractive for foreign investors. In addition, the second half of the year may also see increased investor appetite for FMPs. This will increase corporate bond demand in the market.
Mahendra has a cautious market view. The triggers will drive near term market movement.
Devang feels that most of the bond market pains are behind us. We believe that this will be a year of stable returns. The market has already priced in one more rate hike. Additionally, RBI’s growth and inflation target seems achievable. Overall, market is expected to remain range bound in near term.
Which funds should you recommend to your clients?
All the three fund managers believe that in the current scenario investing in the shorter end of the curve may be a better option. Conservative investors should look at liquid, low duration and ultra-short term categories of fund for investment. Moreover, investors should stagger their investments over the next quarter to benefit from any rise in yields.
Devang mentions that investing in duration funds makes sense during the peak of interest rate cycle. In the current scenario where more rate hikes are expected, fresh investments in duration funds may not lock-in any significant gains. He feels that investors can take selective exposure to credit funds to benefit from high interest rates.
Dhawal believe that only long-term investors having 2-3 year investment horizon can consider investing in duration funds.
Mahendra feels that existing investors in duration funds may stay put. However, investors should wait and watch before making any fresh investments in duration funds.
